By Lucy Waters - Managing Director for Aria Finance
Development exit bridging loans have long been popular with developers. Most don’t set out with the intention of taking of a dev exit bridge, but they serve as a good back-up plan for when things don’t pan out as expected.
Our clients tend to consider them when they need to refinance because a development is behind schedule or they need to release capital quickly, perhaps to fund another site.
While there has always been a need for dev exit finance, it’s fair to say that demand has probably never been higher than it has in the past 18-24 months.
Why? Quite simply, higher interest rates.
When rates are low, demand for property is high, and developers have no problem shifting units or achieving the prices they want.
However, when interest rates are higher – or even rising – that kills demand, making it difficult to move stock without lowering asking prices or offering generous incentives. Understandably, many are reluctant to do this.
A popular alternative is to refinance each unsold unit as a buy-to-let and let them out to tenants as an interim solution. However, there are several drawbacks to this approach.
Firstly, buy-to-let products are longer-term, meaning developers must lock in for longer at a time when borrowing costs are higher. This is unappealing. Secondly, many developers are reluctant to let out their properties before selling them because it can impact the price they can charge further down the line.
Considering these factors, for many developers, the most sensible option is a dev exit loan, which buys them time until borrowing costs fall and demand picks up again.
In our experience, most developers are looking for a hybrid solution, something that doesn’t tie them in for five years but also offers more security than a 12-month bridge.
Any longer and the sums don’t add up most of the time. This is because the longer the term, the more time interest has to roll up, making it potentially unfeasible from a cost perspective.
That said, if the terms are right, dev exit loans can be an extremely useful option for a developer – if the lender has the right criteria in place, of course.
As useful as dev exit loans may be, there isn’t a large pool of lenders that truly understand this space. There are some great lenders that do, but many have unnecessarily restrictive criteria.
The main issues we encounter often revolve around valuation, but there are other sticking points that can hinder some applications.
In dev exit scenarios, it’s crucial to match the property valuation methodology with the development finance valuation methodology. Otherwise, you come up short.
To explain what I mean, let’s use a block of flats as an example. When a development lender looks at the block, they consider the sum of the parts of those flats – the aggregate value.
However, many bridging lenders would be reluctant to base their exposure on the aggregate value of the block. This is because if they needed to repossess, they would have to sell those units individually, as the developer would, rather than selling the block as a whole. This would obviously take time when, preferably, they want the quickest route to exit.
On top of that, when lenders apply a block discount, it can skew the loan-to-value (LTV), hindering borrowers who are already close to the maximum LTV. By the time you add in fees, that 65% LTV loan can look more like 70% or higher. That either means a higher interest rate or, if the lender has a lower max LTV, the deal might not go through altogether.
Finally, how lenders classify dev exits can impact a borrower’s ability to secure funding. For example, the nature of dev exits means they are typically classed as large loans, which some lenders don’t have the ability to fund due to funding restrictions.
Despite these hurdles, I believe the opportunity in the dev exit space is significant and will continue to grow.
As I said, some lenders handle dev exits extremely well. And for these lenders, there is currently a lot of business to be had.
But as ever, the more lenders who spot the opportunity, make the effort to understand the space, and take a more considered view with their criteria, the better the outcome for borrowers. Ultimately, that’s what it’s all about.
